Wednesday, November 9, 2011

The Opportunity Costs of Public Goods

"Every gun that is made, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed, those who are cold and are not clothed. This world in arms is not spending money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children. The cost of one modern heavy bomber is this: a modern brick school in more than 30 cities. It is two electric power plants, each serving a town of 60,000 population. It is two fine, fully equipped hospitals. It is some fifty miles of concrete pavement. We pay for a single fighter plane with a half million bushels of wheat. We pay for a single destroyer with new homes that could have housed more than 8,000 people. This is, I repeat, the best way of life to be found on the road the world has been taking. This is not a way of life at all, in any true sense. Under the cloud of threatening war, it is humanity hanging from a cross of iron...Is there no other way the world may live?" - Dwight D. Eisenhower, "The Chance for Peace," April 16, 1953

What is the best way for the world to live? The best way for the world to live is when each and every taxpayer is given the opportunity to allocate their taxes according to what they believe is the best way for the world to live. In other words...the best way is for taxpayers to be given the opportunity to consider the opportunity costs of their tax allocation decisions.

Frederic Bastiat was the first to fully develop the concept of opportunity cost in his excellent and highly accessible essay...What is Seen and What is Not Seen. From his essay we can easily understand that opportunity costs do not just apply to "bad" things like war...but they apply to even the "best" things. For example...here's Rachel Maddow extolling the benefits of government spending...

Not every idea that is good for the country, is a profit making idea for some company somewhere. It's never going to be a profitable venture for some company to come up with this idea and build it on spec. That's not going to happen! We need some government leadership, frankly, to get something done in common that's going to benefit the country as a whole. - Rachel Maddow, Lean Forward

Unlike Eisenhower...Maddow does not mention any of the other great things that we sacrificed in order to pay for these two public goods. It's fundamentally essential to understand that no two public goods provide the exact same benefit to the country as a whole.

How can public funds be spent in order to maximize the benefit to the country as a whole? Is it simply a matter of statistical analysis? But how can you compare how many people will benefit from a new bridge to how many people will benefit from ten new schools? If 10,000 people would benefit from a new bridge and 10,000 people would benefit from ten new schools...does it really matter then which public good the government spends our taxes on?

This means that the terraces of the Champ-de-Mars are ordered first to be built up and then to be torn down. The great Napoleon, it is said, thought he was doing philanthropic work when he had ditches dug and then filled in. He also said: "What difference does the result make? All we need is to see wealth spread among the laboring classes." - Frederic Bastiat, What is Seen and What is Not Seen.

The White House has a NEW program called Paying for Success. Which begs the question of what we've been paying for this entire time. From the first paragraph...

For too long, the U.S. Government has funded programs based upon metrics that tell us how many people we are serving, but little about how we are improving their lives. As part of this Administration’s commitment to using taxpayer dollars effectively, we are employing innovative new strategies to help ensure that the essential services of government produce their intended outcomes. Now more than ever, federal programs must be measurably effective and designed to do more with fewer resources.

Admittedly, we now have some really amazingly powerful economic functions that the government can use to decide how to spend taxpayer dollars. Can these tools come close to providing the result that would be provided by allowing each and every taxpayer to consider the opportunity costs of their tax allocation decisions? Is this disparity divine or delusional?

The problem is thus in no way solved if we can show that all the facts, if they were known to a single mind (as we hypothetically assume them to be given to the observing economist), would uniquely determine the solution; instead we must show how a solution is produced by the interactions of people each of whom possesses only partial knowledge. To assume all the knowledge to be given to a single mind in the same manner in which we assume it to be given to us as the explaining economists is to assume the problem away and to disregard everything that is important and significant in the real world. Friedrich Hayek, The Use of Knowledge in Society

At the end of the day though it's still 535 congresspeople considering the opportunity costs of their allocation decisions. They've got access to plenty of statistical analysis but do their decisions reflect their desire to maximize the benefits to the country as a whole? Or do their decisions reflect their desire to remain in office?

Even if congresspeople strongly desire to maximize the benefit to society...it's important to understand that they are a few puzzle pieces short of a completed puzzle. How many puzzle pieces are they missing? They are missing all the puzzle pieces that indicate exactly how much each of us truly values the public goods that we care most about. The only way to objectively discern how much somebody truly values something is by how observing how much time/money they are willing to put where their mouths are.

Admittedly, not everybody has the same amount of time and money. But if we want to use taxes to truly tackle the problem of inequality then the only way to effectively do so is if the people who are genuinely concerned about inequality are given the opportunity to allocate their own individual taxes according to what they consider to be the most awesome way of tackling the problem. The point is that no two altruists would tackle the exact same problem using the exact same approach. For example, if they were given the opportunity, Bill Gates and George Soros would not allocate their taxes in exactly the same way. This is because we all have partial knowledge. It's an extremely good thing to have a system that incorporates billions and billions of disparate bits of knowledge.

Mainstream economists fully understand that private resources are efficiently allocated because consumers are forced to consider the opportunity costs of their spending decisions. Forcing taxpayers to consider the opportunity costs of their tax allocation decisions would result in the efficient allocation of public resources. Are there any rational reasons why we wouldn't want public resources to be efficiently allocated? Can anybody make a reasonable argument for not maximizing the benefit to our country as a whole? Thus far, the only response that Keynesian economists have offered to the pragmatarian challenge is the ostrich response.

Here's a passage that nicely summarizing the opportunity cost problem of public goods...

Nevertheless, the classic solution to the problem of underprovision of public goods has been government funding - through compulsory taxation - and government production of the good or service in question. Although this may substantially alleviate the problem of numerous free-riders that refuse to pay for the benefits they receive, it should be noted that the policy process does not provide any very plausible method for determining what the optimal or best level of provision of a public good actually is. When it is impossible to observe what individuals are willing to give up in order to get the public good, how can policymakers access how urgently they really want more or less of it, given the other possible uses of their money? There is a whole economic literature dealing with the willingness-to-pay methods and contingent valuation techniques to try and divine such preference in the absence of a market price doing so, but even the most optimistic proponets of such devices tend to concede that public goods will still most likley be underprovided or overprovided under government stewardship. - Patricia Kennett, Governance, globalization and public policy

1 comment:

Hey, thanks for your comment over at my blog. I came by and checked this out, and I think there are more fundamental questions to be asked about social and individual utility before talking about opportunity costs of public goods. I have a brief post that starts to ask some of those questions: http://goo.gl/dXHVZ -- let me know what you think about that as it relates to your questions here.